India's Central Bank Denied Its Big Payday As Demonetization Flops

On Nov. 8 at 10:15 p.m. Indian Standard Time, India’s Prime Minister Narendra Modi made an unscheduled public address via live television that shook the world’s second most populated country to its core. Starting immediately, he said, all 500 and 1,000 ($15) rupee notes — 86% of the currency in circulation — would cease to be legal tender.

The reason for this move was simple: India’s Ministry of Finance claimed that 500 and 1,000 rupee notes are being used to finance terrorism, fund illegal drug sales, fuel the black market, drive counterfeiting, and pay bribes. This so-called “black money” had reputedly built up to such epic proportions that Prime Minister Modi declared that enough was enough, that he would take it upon himself to wash his country’s currency supply in one fell swoop.

Hundreds of billions of dollars — $224 billion worth of currency — was essentially recalled and newly designed 500 and 2,000 rupee notes would be printed and distributed to replace it. The people of India were given just 50 days to redeem their old notes for the new ones (which were often unavailable) or deposit their cash into bank accounts.

An activist of Congress party holds banned 500 and 1,000 rupee notes during a protest against the government's decision to withdraw high denomination notes from circulation, in front of Reserve Bank of India. (AP Photo/Mahesh Kumar A. )

This announcement was a shock to the country. There were no run ups to the announcement, no warnings, not even any rumors. It was a top secret undertaking, and this was by design. This was a strategic move by Modi to catch India’s massive black market with its proverbial pants down.

As it turned out, this demonetization initiative was even plotted in clandestine backroom meetings in Modi’s private residence. Hasmukh Adhia, a bureaucrat who served as Modi’s principal secretary when he was chief minister of Gujarat state, was specially selected to mastermind the scheme together with a team of five trusted researchers who were likewise sworn to secrecy.

The idea was that India’s central bank would revoke its backing of the bank notes that the black market and counterfeit empire was built upon, rendering them worthless pieces of paper. At that time it was thought that those involved in the shadow economy wouldn’t be able to redeem their “black money” and the national reserve would be the recipient of a colossal pay day.

Part of the exchange process for old notes consisted of a proverbial dragnet to catch black money by formally scrutinizing large transactions and then doling out the appropriate taxes or fines. India banked on the black market simply not showing up for fear of being caught, and just sit idle as their illicit gluts of cash unceremoniously expired into worthless pieces of paper.

Theoretically, by having a large amount of canceled banknotes going unredeemed, the Indian government could essentially pocket the balance, which was estimated to be as high as 21% of the currency being recalled — or roughly $45 billion.

“Now it is not being explicitly stated — and in some cases they are going to deny it — but if a certain amount of cash does not come back then the central bank no longer has to account for that money,” said Arpan Nangia, the head of the India desk for HSBC’s commercial banking division. “So, for example, if a billion dollars does not come back then it's like a billion dollar profit for the central bank.”

Unfortunately for Modi and India’s central bank, this payday never materialized. As of now, over 82.5% of the recalled notes have been turned in, and it is estimated that by the time the redemption period is over on December 30th essentially all nullified notes will be officially collected — white and black alike.

How the black market was able to take such large amounts of illicit funds and redeem them via the demonetization program is not yet fully understood. Some theories have it that large amounts of previously inactive bank accounts were utilized or money was laundered via various tax-exempt entities. India’s Enforcement Directorate is currently investigating bank branches throughout the country.

However, India also offered an amnesty program for black market players, where the government would accept illicit cash at a 50% tax, and how much of the recovered notes were part of this program is currently unknown.

That said, the large amounts of black money that Modi and Company were attempting to wipe out may never have existed in the first place. Prior to this recent wave of demonetization, various studies have indicated that only 6% or so of India’s black market wealth is actually kept in cash. In 2012, India’s Central Board of Direct Taxes came out and publicly advised against demonetization on the grounds that most of country’s illicit wealth is kept in real estate, bullion, and jewelry — not in 500 and 1,000 rupee banknotes.

I'm the author of Ghost Cities of China and have been traveling perpetually since 1999 -- through 88+ countries. I can often be found in some new city or somewhere along the New Silk Road.

I'm a perpetually traveling writer who focuses on new cities (ghost cities), the New Silk Road, and international e-commerce as seen from the ground. I am the author of "Ghost Cities of China: The Story of Cities Without People in the World's Most Populated Country," a book...